Section 398 · Collection & recovery
Section 398 of the Income-tax Act, 2025 — Consequences of Failure to Deduct/Collect or Pay TDS/TCS (Assessee-in-Default, Interest, Disallowance)
By CA Rajat Agrawal
Updated 05 Jul 2026
Chapter XIX
📜 What the law says — Section 398, Income-tax Act 2025
398. (1) If a person, including the principal officer of a company,—
(a) who is required to deduct or collect any amount under this Act; or
(b) referred to in section 392(2)(a), being an employer,
does not deduct or pay, or does not collect or pay, or after so deducting or collecting
fails to pay, the whole or any part of the tax, as required by or under this Act, then
such person shall be deemed to be an assessee in default in respect of such tax in
addition to any other consequences which that person may incur under this Act.
(2) Irrespective of anything contained in sub-section (1), any person,—
(a) including the principal officer of a company, who fails to deduct; or
(b) responsible for collecting tax as per section 394(1) (Table: Sl. Nos. 1 to
5 and 9), who fails to collect,
the whole or any part of the tax, as required under this Chapter, on the amount paid
or credited to the account of payee or, on the amount collected or debited to the
account of the buyer or licensee or lessee, as the case may be, shall not be deemed
to be an assessee in default in respect of such tax, if the payee or buyer or licensee
or lessee has—
(i) furnished his return of income under section 263;
(ii) taken into account the amount for computing income in that return of
income; and
(iii) paid the tax due on the income declared by him in such return of income,
and the person furnishes a certificate to this effect from an accountant in the form
as may be prescribed.
(3) (a) Without prejudice to sub-section (1), if any person, as referred to in that
sub-section does not deduct or collect the whole or any part of the tax or after
deducting or collecting fails to pay the tax as required under this Act, he shall be
liable to pay simple interest—
(i) at 1% for every month or part of a month on the amount of such tax from
the date on which such tax was deductible or collectible to the date on
which such tax is deducted or collected; and
(ii) at 1.5% for every month or part of a month on the amount of such tax
from the date on which such tax was deducted or collected to the date
on which such tax is actually paid;
(b) the interest referred to in clause (a) shall be paid before furnishing the statement
as per the provisions of section 397(3)(b);
(c) if the person referred to in sub-section (1) is not deemed to be an assessee in
default under sub-sectio
In plain language
What Section 398 is about
When a person is legally required to deduct tax at source (TDS) or collect tax at source (TCS) and fails to do so — or deducts/collects it but does not pay it to the Government on time — the law does not simply let it go. Section 398 of the Income-tax Act, 2025 sets out the full chain of consequences: the person is treated as an "assessee-in-default", becomes liable to pay the tax itself, pays interest on the shortfall, faces a charge on all their assets, and may attract penalty and prosecution under other sections.
Section 398 consolidates what were three separate provisions under the old Income-tax Act, 1961 — Section 201 (TDS default) and Section 206C(6A) to (8) (TCS default) — into a single, unified code covering both TDS and TCS. It is the "enforcement engine" that sits behind the entire Chapter XIX-B (TDS/TCS) machinery.
Who it applies to
- Any deductor — an employer, business, company, firm, contractor, tenant or buyer required to deduct TDS under Sections 393 onwards (salary, contractor payments, rent, professional fees, interest, commission, property purchase, etc.).
- Any collector — a seller required to collect TCS under Section 394 (scrap, timber, minerals, motor vehicles, foreign remittances under LRS, etc.).
- The principal officer of a company and, in appropriate cases, partners of a firm can be held responsible.
The three distinct defaults it covers
- Non-deduction / non-collection: tax was deductible/collectible but the person did not deduct or collect it at all.
- Short deduction / short collection: less than the required amount was deducted or collected.
- Deducted/collected but not paid: the tax was correctly withheld but not deposited with the Government (this is the most serious default and can trigger prosecution).
Interest — Section 398(3)
Interest runs at two different rates depending on the type of lapse. For a non-deduction / non-collection, interest is 1% per month or part of a month from the date the tax was deductible/collectible up to the date it is actually deducted/collected. Once tax is deducted but paid late (or after deduction, deposited late), interest is 1.5% per month or part of a month from the date of deduction/collection to the date of actual payment to the Government. Even one day into a new month counts as a full month. This interest must be paid before filing the TDS/TCS statement.
The key relief — Section 398(2)
A deductor/collector who failed to deduct or collect is NOT treated as an assessee-in-default if the payee (recipient) has: (a) filed their income-tax return, (b) included the relevant income in that return, and (c) paid the tax due on it. To claim this relief, the deductor must obtain an accountant's (CA) certificate in the prescribed form (broadly equivalent to the old Form 26A / 27BA). Note: even when this relief applies and no tax is recovered, interest for the intervening period is still payable, and the deductor is deemed to have deducted and paid tax only on the payee's return-filing date.
Charge on assets and time limit
- Section 398(4) creates a charge over all the assets of the defaulter for the unpaid tax plus interest — effectively securing recovery.
- Section 398(5) caps the limitation: an order declaring a person an assessee-in-default cannot be passed after the later of six years from the end of the tax year in which the tax was deductible/collectible, or two years from the end of the tax year in which a correction statement is delivered.
- Section 398(7) restricts penalty under Section 412 unless the officer is satisfied the failure was without good and sufficient reasons.
Interaction with the 30% disallowance — Section 35
Section 398 is not the only cost. Under Section 35 (the successor to the old Section 40(a)), if TDS on a sum payable to a resident is not deducted, or is deducted but not paid by the due date for filing the return, then 30% of that expense is disallowed while computing business income. For payments to non-residents, 100% can be disallowed. The disallowed amount is allowed back in the later year when the TDS is finally paid. So a single TDS lapse can hit a business twice — recovery-plus-interest under Section 398 and a disallowance of the expense under Section 35.
Practical implications
- The deductor bears the tax even though economically it belonged to the payee — so recovering it back from the payee becomes a commercial problem.
- Interest under Section 398 is not an allowable business expense, so it is a pure cash cost.
- Failure to deposit deducted tax can lead to prosecution — treat deducted TDS as trust money owed to the Government.
- Keep CA certificates and payee return proofs ready to invoke Section 398(2) relief.
💡 Example
Example 1 — Non-deduction on a contractor bill. ABC Pvt Ltd pays a resident contractor ₹10,00,000 in June 2026 but forgets to deduct 1% TDS (₹10,000) under Section 393. It finally deducts and deposits the ₹10,000 in December 2026. Interest under Section 398(3) at 1% per month for the period from the deductible date (June) to actual deduction (December) — 7 months — is ₹10,000 x 1% x 7 = ₹700. Separately, under Section 35, because TDS was not deducted by the return-filing due date, 30% of ₹10,00,000 = ₹3,00,000 is disallowed and added to ABC's taxable income for that year (allowed back in the year TDS is finally paid).
Example 2 — Deducted but paid late. XYZ deducts ₹50,000 TDS on rent on 30 April 2026 but deposits it only on 20 July 2026 instead of by 7 May. Interest at 1.5% per month or part thereof runs from the deduction date (April) to the payment date (July) — counted as 4 months — so ₹50,000 x 1.5% x 4 = ₹3,000 interest, payable before filing the TDS statement. Here no 30% disallowance arises because TDS was deducted and eventually paid.
A relatable story. Meena runs a small design studio in Jaipur and pays a freelance developer ₹4,00,000 without deducting TDS, assuming "he'll pay his own tax." At assessment, the officer proposes to treat her as an assessee-in-default. Meena's CA shows that the developer had already filed his return, declared the ₹4,00,000, and paid tax on it — and furnishes the accountant's certificate. Under Section 398(2), Meena escapes recovery of the tax and the 30% disallowance. But she still had to pay 1% per month interest for the delay period — a reminder that the relief covers the tax, not the interest.
| Situation | Interest rate (Sec 398(3)) | Period it runs for | Section 35 disallowance |
|---|
| Tax not deducted / not collected at all (resident payee) | 1% per month or part | From date deductible to date actually deducted | 30% of the expense |
| Tax deducted/collected but paid to Govt late | 1.5% per month or part | From date of deduction to date of payment | 30% (if not paid by return due date) |
| Tax not deducted on payment to a non-resident | 1% per month or part | From date deductible to date deducted | Up to 100% of the expense |
| Payee already filed return & paid tax (Sec 398(2) relief + CA certificate) | Interest still payable | Up to payee's return-filing date | No disallowance |
| Time limit to pass "assessee-in-default" order | Later of 6 years from end of relevant tax year, OR 2 years from end of tax year of correction statement (Sec 398(5)) |
Related sections
Section 393 — TDS: deduction of tax at source Section 394 — TCS: collection of tax at source Section 35 — 30% / 100% disallowance for TDS default Section 397 — TDS/TCS statements, returns and challans Section 412 — Penalty for failure to deduct/collect tax Section 263 — Due date for filing the return of income
Frequently asked questions
What does it mean to be treated as an 'assessee-in-default' under Section 398?
It means the deductor/collector becomes personally liable to pay the TDS/TCS they should have deducted or collected, along with interest. Recovery can be enforced against them, and a charge is created on all their assets under Section 398(4).
What is the interest rate for late TDS payment under the 2025 Act?
Interest is 1% per month (or part of a month) for failure to deduct, and 1.5% per month (or part) where tax was deducted but paid to the Government late. Even one day into a new month is counted as a full month.
Can I avoid being an assessee-in-default if I forgot to deduct TDS?
Yes, under Section 398(2), if the payee has filed their return, included the income and paid the tax on it, you are not treated as in default. You must obtain a chartered accountant's certificate in the prescribed form as proof, but interest for the delay period is still payable.
Is the 30% disallowance the same as the Section 398 interest?
No, they are separate consequences. Section 398 handles recovery of the tax plus interest, while Section 35 (successor to old Section 40(a)) disallows 30% of the expense for residents (up to 100% for non-residents) when computing business income.
What is the time limit for the department to declare me an assessee-in-default?
Under Section 398(5), no order can be passed after the later of six years from the end of the tax year in which the tax was deductible/collectible, or two years from the end of the tax year in which a correction statement is delivered.
Is interest paid under Section 398 an allowable business expense?
No. Interest on TDS/TCS default is treated as a consequence of failing to comply with the law and is not deductible while computing business income, making it a genuine out-of-pocket cost.
Which old Income-tax Act, 1961 sections does Section 398 replace?
Section 398 consolidates Section 201 (TDS default) and Section 206C(6A) to (8) (TCS default) of the 1961 Act into a single unified provision covering both TDS and TCS consequences.
C
CA Rajat Agrawal
Chartered Accountant, EaseValue · Reviewed 05 Jul 2026
This explainer is prepared and reviewed by EaseValue's tax team, based on the text of the Income-tax Act, 2025 (as amended by the Finance Act, 2026).
Disclaimer: This page explains the law in general terms for education and is not professional advice. The Income-tax Act, 2025 takes effect from 1 April 2026; provisions, thresholds and interpretations may change. Please confirm your specific position with our team before acting.
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